Buckle Up: Where Interest Rates Are Taking the Economy
By Nick Fouriezos
Hear the rattling of coins? See your piggy bank shaking on the fireplace mantle? If you’re worried about the future of your savings and investments, know that you’re not alone. The Federal Reserve sent tremors through global markets last month by declaring that it plans to raise interest rates twice by the end of 2023, the central bank’s most consequential statement yet about the need to put the brakes on inflation. What the Fed decides and how the economy responds will impact all of us. Today’s Daily Dose explores the tectonic nature of these economic shifts, key players and what this could mean for you.
the tremors affecting you
Adults with high-yield savings accounts should see their interest rates rise slightly, while loan and credit card rates will remain stable. However, because the Fed isn’t acting immediately to combat inflation concerns, don’t expect prices to dip in certain industries that have exploded recently. The cost of medical goods fell, but the cost of used cars and trucks has sharply risen. Airline fares have also increased by 24% and energy costs are up 28% since May 2020. Those increases represent some of the largest year-to-year increases ever seen in the Consumer Price Index — adding fuel to concerns of inflation, which may lead the Fed to think about acting sooner than expected. “The question is: Does the Fed say we really need to damp down the party a little bit and have a cup of tea, instead of adding more liquor to the punch bowl?” Richard Warr, a finance professor at the Poole College of Management at North Carolina State, tells OZY.
Planes, Trains and Automobiles
Not everyone shares those worries. Some, including the Biden administration, believe those increased costs are simply part of the pendulum swing caused by the economy opening up after its year-long pandemic shutdown. The White House is backing a $579 billion infrastructure deal to improve American roads and transit systems, despite concerns from some economists that it — along with trillions in similar spending measures — could ramp up inflation even more. Publicly, Fed Chairman Jerome Powell has backed the White House, telling Congress on June 22 that the evidence suggests the factors behind rising prices “will wane over time.” Whether your potholes get filled and railways get upgraded may depend on whether Powell and the Biden team are right. “There is so much going on, coming out of the pandemic, they’re saying, ‘let’s see how this is going to play out in the short run,’” Warr says. “Maybe prices will have calmed down and we can make a more rational decision then.”
Any rise in interest rates could dampen the fiery U.S. housing market, so homeowners looking to refinance should do so now, while low rates could still knock a few hundred off their monthly mortgage payments. Still, while the housing market is bacon-grease hot, that doesn’t mean it’s in a bubble, argues Jim Cramer, the CNBC host of Mad Money (Watch him on The Carlos Watson Show). Unlike the 2008 housing crisis, homebuyers today have good credit and savings. Surging demand is coming from previously skeptical millennial buyers, who are now the most optimistic generation about real estate, according to a recent OpenDoor study. Sellers can expect their home values to keep rising this year, while buyers should be ready to tack a few more G’s onto their offers.
But your mortgage isn’t the only thing you can refinance. You can also take advantage of low short-term rates to refinance other debts — everything from car to student loans. If you have a major purchase or home project coming up, taking out a home equity line of credit may be a smart move. The Fed has put an expiration date on those bargain rates, so the low interest won’t stay. Meanwhile, those worried about mounting inflation may choose to shift retirement funds and investments into other spaces, from the stock market to gold … or maybe even Bitcoin (if you can stomach the volatility), which some believe could be an even more powerful inflation hedge. If the Fed does act to raise interest rates to combat inflation though, consumers may see another benefit, Warr says: “It will perhaps slow the acceleration in the growth of prices of things they want to buy.”
financial ground breakers
Europe was facing the worst economic crisis since World War II when Lagarde became the first female finance minister of a G-8 nation — building France up as one of the industrial world’s most resilient economies while enacting swift fiscal actions to head off the Great Recession in 2009. Since then, Lagarde, 65, has headed the International Monetary Fund and, since 2019, the European Central Bank. The daughter of teachers has had a freewheeling career, from performing as a teenager with the French national synchronized swimming team to serving as a U.S. congressional intern during the Watergate hearings. But with monetary policy increasingly politicized, can Lagarde navigate treacherous fiscal waters as economies grapple with potential post-COVID austerity measures?
When journalists asked what kind of “bird” Nabiullina was — a not-so-subtle way of asking if she considered herself a fiscal “hawk” or “dove” — the head of Russia’s central bank wryly said she wasn’t sure she was a bird at all. But when, at a later press conference, she wore the brooch of a white swan, Russian media began speculating if she was sending a secret message about the Russian economy. You don’t need to read brooches to know that Nabiullina is a talented economist, managing everything from a flood of economic sanctions from the West to an overwhelming dependence on oil and gas at a time the world is shifting to clean fuels. Nabiullina has also pushed Moscow to develop its own digital currency, which could help Russia join China and Iran in inoculating their economies from sanctions by reducing their dependence on the U.S. dollar.
Will he go from Bitcoin-buster to Bitcoin-broker? Emefiele has enforced strict currency controls and a multiple exchange rate system aimed at stopping the slide of Nigeria’s currency, the naira. The alignment between his approach and the policies of President Muhammadu Buhari is believed to have helped Emefiele become the first Nigerian central bank head to be approved for a second term since the country’s return to democracy in 1999. But in February, the central bank sparked confusion by first appearing to ban cryptocurrencies and then walking back its regulatory crackdown. Nigeria boasts one of the world’s youngest and most crypto-curious citizenries. And now the central bank is discussing the launch of its own pilot digital currency before the year’s end, making Emefiele’s about-face complete.
seismic activity around the globe
Will the Dollar Dip?
The U.S. and the U.K. have had a global vaccination advantage that’s allowed them to open up their economies sooner than other nations, an advantage that will quickly lessen in the coming months, warns Wells Fargo Securities head of macro strategy Michael Schumacher. “Now a lot of countries are catching up, and you could view that as a proxy for future economic activity.” American currency could also take a hit if the Fed acts too slowly in responding to inflation fears. “The dollar is losing some of those tailwinds,” Schumacher says.
Brazil’s Big Bet
Unlike the U.S. Federal Reserve, Brazil’s central bank is not waiting to slay the threat of inflation. In June, it raised interest rates for the third time this year and indicated that more hikes might be on the way. Bank boss Roberto Campos Neto has promised that the institution is “100% committed” to matching rates with inflation goals. The continued strength of the real has helped ease some of the pain on Brazilians so far, meaning Neto’s wager could pay off.
The city-state’s central bank is worried about the increased popularity of buy now, pay later services with Gen-Z Singaporeans, warning that easy credit apps were blitzing the market. It has launched a media campaign to warn consumers how quickly such schemes could make them “a hostage to your spending habits.” Could other central banks similarly direct consumer behavior away from dangerous money-lending schemes … or, in the case of the United States, do a better job educating the public about taking on student loan debt?
The Bank of Japan, the world’s second-largest central bank, announced last month it was launching a plan to fund financial firms that increase their loans to activities that fight climate change — following a recent trend of more innovative central banks tying monetary policy to green policies. It makes sense for the island nation, which is particularly prone to some of the world’s worst climate disasters, from tsunamis to typhoons. Japan’s global aid agency and some of its top private lenders are also turning away from financing coal-fired power plants.
The Chips Are Down
Skyrocketing demand for electronic products during the pandemic, disrupted trade routes worsened by a China-America trade war and Taiwanese drought limiting water purification have all led to a worldwide chip shortage ramping up costs in at least 169 industries. That’s created surging prices for new cars, phones, gaming consoles, smartphones and other technologies. It also creates concerns of chip-based economic vulnerabilities, considering that four countries — Taiwan, South Korea, China and Japan — produce three-fourths of the world’s chip supply. The effects of the chip shortage are so great some wonder if it is one of the primary drivers behind inflation concerns: “When you see there is inflation, it’s this basket of goods and services, but it’s uneven — often driven by one or two items,” Warr says. His point? If real estate, travel and chip-driven cars are driving most of the market’s rising prices, mostly due to pandemic-related causes, perhaps a Fed rate increase won’t be necessary.
the shifting plates of economic theory
Is Hyperinflation Already Here?
For more than a century, economists and central banks have measured inflation by calculating the rise in prices of a basket of consumer goods and services. But many people no longer spend the bulk of their incomes on bare necessities, devoting significant sums to buying bonds, shares and other investment instruments. Now for a little secret: If you incorporated all these expenses into economic calculations, some experts believe America witnessed nearly 20% inflation in 2020, as opposed to the 2% that is frequently touted as the annual rate of inflation.
Gross Anything Else
A country’s GDP is an objectively insufficient measure of its financial well-being, yet it is used as the shorthand economic indicator for the world. Many nations — including Germany, France and Britain — are investigating more complex national measures, as are innovative economists. One idea, proposed in the Harvard Business Review, suggests a set of indicators that includes equitable distribution of wealth and sustainable growth that preserves the future with climate change action and resource preservation. Another suggestion? The Gross National Happiness indicator, which Bhutan uses. After all, if you’re not happy, what’s your money really worth?
Decentralize It All
Modern finance has been built around the notion of banks as regulators of safe and reliable monetary transactions. But blockchain-based finance could in theory eliminate the need for such intermediaries, providing a secure landscape for loans and purchases. Such decentralized finance — or DeFi — could make currency flow more efficient, faster and, perhaps, fairer. Its supporters believe it’s the route to creating a true free market that doesn’t protect the wealthiest above others. Shark Tank investor and billionaire Mark Cuban has been particularly bullish about cryptocurrency-backed DeFi, although he also has suffered financial losses due to its volatility. But central banks aren’t sitting around either. More and more of them are exploring blockchain-based finance themselves as a way to own, and then regulate, such systems before they become a threat.
Eliminate This Tax
Requiring cash bail to avoid jail time is now being recognized by experts in many U.S. states and world governments as essentially a tax on being poor. After all, people unable to afford posting bail can be incarcerated for months before even being proven guilty, sometimes leading to them losing their jobs or homes, making their financial position even worse. One of the worst such cases was that of Kalief Browder, who spent three years in Rikers Island prison without trial — two in solitary confinement — for allegedly stealing a backpack. Two years after his release in 2013, he hanged himself, sparking outcry and movement from criminal justice experts to end cash bail. New Jersey and Alaska have already ended cash bail in most cases, while globally, few other countries besides the Philippines use a cash bail system at all.